Working Paper: NBER ID: w23970
Authors: Burak R. Uras; Ping Wang
Abstract: Economy-wide institutional deficiencies causing factor misallocation have been emphasized as essential determinants of aggregate TFP differences. This paper argues that production flexibility at the micro-level is an economic characteristic that should be given priority in TFP aggregation exercises. We investigate a heterogeneous firms model with two distinct notions of flexibility: (i) the firm-specific capacity to optimize over a set of production techniques that serve to organize capital and labor; and, (ii) the industry-specific substitutability between efficient units of capital and labor. We show the presence of a strong interaction between "ability to choose techniques" and "input substitutability": high complementarity at the industry-level amplifies imperfections associated with techniques choice at the firm-level. Using the micro-founded structure, we develop measures for factor, output and technique distortions across a distribution of firms and quantify their TFP effects. For a broad range of U.S. manufacturing industry clusters, technique distortions generate more TFP losses than misallocation resulting from capital and output distortions, with larger TFP gains from removing technique distortions in industries that exhibit high degrees of factor complementarity. Our key quantitative results are robust to outliers, production function specification, mismeasurement and parameterization of the model and are strongly present in developing country datasets.
Keywords: Total Factor Productivity; Production Flexibility; Misallocation; Heterogeneous Firms
JEL Codes: D24; E23; O11; O33
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| production flexibility (L23) | total factor productivity (TFP) (D24) |
| low production flexibility (D24) | amplification of cost distortions (H31) |
| high complementarity between factors (F16) | amplification of cost distortions (H31) |
| technique distortions (C51) | industry-level TFP (L19) |
| production flexibility + high complementarity (D10) | greater TFP losses from technique distortions (F16) |